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[Note: illustrate the below numericals in detail with justification on findings] 1) Short term (one year) interest rates over the next 6 years will be

[Note: illustrate the below numericals in detail with justification on findings]

1) Short term (one year) interest rates over the next 6 years will be 0.5%, 0.6%, 0.7%, 0.76%, 0.80% and 0.84%.

  • Using the expectations theory, what will be the interest rates on a three, four, and six-year bonds?
  • Assuming the investors prefer holding short-term Treasury bonds, a liquidity premium of 10 basis points is required for each year of a bond's maturity. What will be the interest rates on two, four, and six-year bonds?

2) A bank currently has $150 million in deposits, and $15 million in reserves. The required reserve ratio is 10% and federal funds rate of 0.25%. Suppose there is a deposit outflow (i.e. someone withdraws funds from their account) for $5 million. Please provide answers to the following questions with explanations:

  • Would this bank still comply with the Feds requirement of keeping 10% of its deposits in the form of reserves? Please explain
  • What would be the cost for this bank to comply with this regulation if the bank decides to borrow from another bank to eliminate its reserve shortage?
  • What would be the cost for this bank to comply with its required reserves if the bank decides to borrow from the Fed at a discount rate of 0.75%?
  • Please explain why required reserves serve as insurance against deposit outflows.

3) Consider a commercial bank policy to maintain 12% of deposits as reserves. The bank currently has $10 million in deposits and holds $400,000 precautionary excess reserves. What is the required reserve on a new deposit of $50,000?

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